Keeping Up With the Rapidly Expanding Suite of China ETFs

| About: iShares China (FXI)
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This article originally appeared at on 3/11/2010.

It wasn’t long ago that ETF exposure to China in the investment community equated to “FXI.”

The iShares FTSE/Xinhua China 25 Index ETF (NYSEARCA:FXI) was launched in 2004, well ahead of the many peers that have spawned recently, so it’s no surprise that the ETF holds the lion’s share of assets (about $8 billion currently). FXI owns the 25 largest and most liquid Chinese companies, so there's clearly a large-cap skew. However, like everything else in the ETF industry, innovation and improvement are the driving forces behind new product launches from ETF sponsors eager to carve into FXI’s market share.

For the past six years, retail and institutional investors bought FXI as their portfolio exposure to China, but it is near certain that most put little thought in the level of diversification that FXI offered. The product owns 25 stocks based in China, and the top 10 holdings make up more than 60% of the fund. Furthermore, four of the top five holdings are China Mobile (NYSE:CHL),China Construction Bank, Industrial and Commercial Bank of China, China Life Insurance (NYSE:LFC), and Bank of China.

See a theme here? That’s right, large-cap financials make up 46% of the ETF. Is this a good or bad thing? It’s hard to say really, but for an investor who thinks they own “China” in their portfolio with a stake of FXI, it may be more accurate to state that they are concentrated in the Chinese Financials sector, with some scattered exposure to other industry sectors.

Another iShares China offering, iShares FTSE China HK Listed Index (NASDAQ:FCHI), is similar to FXI, although it owns more than 25 securities. Most of the constituents of the index, however, are large-cap oriented, and this ETF too is heavily skewed toward Financials (45% of the fund).

Similar to FXI, State Street offers SPDR S&P China (NYSEARCA:GXC), which is also a cap-weighted ETF based on the S&P China BMI Index. Financials are also
heavily over-weighted in this index, weighing in at 33, and like FXI, this ETF has a large-cap bias.

So investing in China for an ETF investor historically has offered little in the way of flexibility for those who wanted to play different sectors, or perhaps smaller cap, more speculative companies. This fact obviously wasn't lost on competitors to iShares, as a host of China-based ETFs have hit the market in the recent past. PowerShares offers more specialized exposure to China with PowerShares Golden Dragon Halter USX China (NASDAQ:PGJ), which seems to spread out the sector-specific risk better than GXC or FXI, having its highest sector weighting in Energy (21.34%), and healthy doses of Info Tech (18.69%), Telecom (16.93%), and others. PGJ is skewed toward large cap, with about 52% of the portfolio in large caps and the remainder in mid and small caps.

Claymore is now in the China ETF space as well, and for those investors looking to trade risk for higher returns, they may want to consider Claymore/AlphaShares China Small Cap Index (NYSEARCA:HAO). Those seeking broader diversification among companies of different market capitalizations meanwhile may look atClaymore/AlphaShares China All Cap (NYSEARCA:YAO).

An upstart ETF provider called Global X has created a niche and launched a suite of sector based China ETFs that allow the investor to make specific Chinese industry sector bets.Global X China Financials (NYSEARCA:CHIX), Global X China Industrials (NYSEARCA:CHII), Global X China Consumers (NYSEARCA:CHIQ), Global X China Materials (NYSEARCA:CHIM), Global X China Technology (CHIB), and Global X China Energy (NYSEARCA:CHIE) are the offerings at the moment, and clearly allow the investor to build more specialized exposure to China into their portfolios.

Claymore competes in the Chinese Technology space as well with Claymore China Technology (NYSE:CQQQ).

Finally, from a sector standpoint, another relative newcomer to the ETF issuer space, Emerging Global Shares, has launched a very unique product that has caught much attention -- INDXX China Infrastructure Index (NYSEARCA:CHXX) offers exposure to China’s infrastructure sector, which has been a topic of great interest and discussion in recent years.

With a variety of offerings out there now, investors who currently own FXI and are uncomfortable with any of the sector exposures within the fund can neutralize that sector exposure to some degree by using any of these sector funds as a short position against the FXI long. Conversely, it may be advantageous for some investors to unwind an FXI, FCHI, or GXC position that they established a long time ago, before the specialized and sector-based China ETFs were available, in order to build out portfolio exposure that's more customized according to specific sector views.

It also shouldn't be a surprise to anyone that in the past year since the markets bottomed, Chinese equities have performed extremely well, with HAO leading the pack with a 136.13% trailing one-year return, followed by PGJ (100.15%), GXC (89.79%), FXI (74.87%), and FCHI (44.71%). The other China-based ETFs mentioned above don't have trailing one-year returns because these products only have a limited amount of trading history since beginning to trade publicly, however, with some study, an investor can figure out how the funds would have fared simply by looking at how the underlying securities have performed.

Some investors may naturally say, “Why would I want to buy into a country or sector that has run up more than 100% in the past year? I don’t want to buy if this rally loses steam and face a correction.” That said, there has been some talk about the Chinese government slowly withdrawing the economic stimulus plan that they put into effect in the midst of the economic downturn of 2008 and early 2009. The plan indeed worked, and helped China get back on track, but many investment pundits believe that if government intervention is withdrawn too quickly or improperly, this could hurt the Chinese equity market.

How does an ETF/ETN investor play this? Two ETNs exist that track the exchange rate of the Chinese Yuan currency against the US Dollar: Wisdom Tree Dreyfus Chinese Yuan (NYSEARCA:CYB) and Market Vectors Chinese Renminbi/USD ETN (NYSEARCA:CNY). Those who feel that Chinese equities will weaken from today’s levels and those who believe that China could reset the Yuan higher will want to consider CYB and CNY as outright long positions, or perhaps as hedges against their long Chinese equity ETF positions.

Disclosure: No positions